ServiceNow (NYSE:NOW) presents itself as an interesting investment argument from a growth perspective and a broader business dynamic perspective: Having widened upper line with a CAGR of around 100% between 2013 and 2022, ServiceNow could still have attractive growth space ahead as the company is poised to play an important role in driving digital transformation. In this regard, ServiceNow enables organizations to facilitate the removal of application/communication barriers and improve productivity by automating business operations in various sectors such as sales, HR and IT. And if management estimates are correct, then NOW could potentially serve a total addressable market of $220 billion. That said, it is impossible for me to justify an investment 15x EV/Sales. In fact, based on a residual earnings model that anchors its data on company fundamentals as well as optimistic outlooks Based on analyst consensus estimates through 2025 and final growth of 4.25% thereafter, I estimate that NOW stock could be overvalued by more than 50%. Based on valuation, I assign an Underweight/Sell rating.
As a reminder, ServiceNow stock has strongly outperformed the entire stock market since the start of the year, also compared to the “Tech” benchmark index. Year to date, NOW stock is up just over 82%, compared to a gain of about 25% for the S&P 500 (SP500) and a gain of nearly 56% for the tech-heavy Nasdaq 100 (QQQ).
ServiceNow: revolutionizing workflows with cloud-based solutions
ServiceNow is at the forefront of the digital workflow revolution, delivering cloud-based solutions that streamline and automate business processes. Founded in 2004, the company has evolved from its IT service management (ITSM) roots to become a leader in digital transformation across various organizational functions, including HR service delivery, customer service and security operations. In this context, ServiceNow operates in the broader enterprise software and cloud computing sector, meeting the growing demand from organizations for workflow optimization.
Having discussed ServiceNow’s product offering with five actual customers of the company’s NOW platform, I understand that ServiceNow’s competitive position is based on the company’s broad capabilities around optimizing workflows. work, the user-friendly interface, the scalability of use and the emphasis on customer-centric innovation. Additionally, and specifically with respect to ServiceNow’s core market ITSM, I have learned that there are few alternative vendors offering a competitive solution to the NOW platform. In fact, only that of Atlassian (TEAM) The Jira solution could offer similar value; However, Jira is mainly aimed at teams close to DevOps.
Market white spaces to support strong growth through 2027
Anchored by NOW’s competitive position, it is worth emphasizing that the company is in a leading position to capture growth in the rapidly growing cloud computing market for workflow management, an opportunity that ServiceNow management believes has 220 billion dollars in 2025.
In highlighting ServiceNow’s TAM, management repeatedly emphasized that there is still significant room for growth in higher-tier accounts, both in terms of new logo and logo penetration. More specifically, ServiceNow underlines that its existing customer base of approximately 8,000 customers is significantly lower than the estimated 50,000 potential customers (customers with more than $100 million in revenue or 1,000 employees), with international expansion being a key growth driver. In this regard, ServiceNow has doubled its sales in the global enterprise IT market, having signed sales and collaboration agreements with arguably all the major systems integrators and technology companies.
Additionally, I believe ServiceNow is advantageously positioned to benefit from the near-term tailwinds of the generative AI evolutionary cycle. Investors should consider that ServiceNow has already launched an AI feature for the NOW platform, called NOW Assist, what resulted in 40% PRO+ adoption and 25% ASP increase. From a practical perspective, AI should help the NOW platform achieve higher deviation rates for incidents, faster root cause analysis, and use of natural language for summaries and analysis post-incidents. Additionally, AI could support various aspects of digital workflows such as automating shared services, increasing agent productivity, and creating automated knowledge.
That said, I am optimistic about ServiceNow’s growth prospects for the next 5 years and agree with the analyst consensus. projections of approximately 21% overall CAGR until 2028.
Financial performance and metrics
An additional argument in favor of ServiceNow, from a business perspective, concerns the company’s strong performance and financial indicators. Over the past decade, ServiceNow has aggressively and consistently expanded its revenue, growing approximately 100% between 2013 and 2023 TTM, bringing the company’s revenue to nearly $8.5 billion. During the same period, ServiceNow also increased its gross margin, with gross profit margin increasing from 63% in 2013 to 79% for TTM 2023. In this regard, investors will certainly appreciate that the lion’s share of the revenue figure ServiceNow’s business is made up of subscriptions. revenue based on annual recurring revenue (ARR).
A downside to ServiceNow’s finances relates to the company’s sales-intensive business model, with SG&A costs consuming nearly 60% of the company’s gross profit. And with R&D expenses reducing gross profit by another 30%, that leaves only about 10% as operating profit, or about $650 million in dollar terms. That said, it will be interesting to see how ServiceNow can leverage surgical jaws on a higher line.
Valuation: set the TP at $320/share
To assess the intrinsic value of a company, I am a big proponent of using a residual earnings model, which is based on the idea that a valuation should equal a company’s discounted future earnings after loading of capital. According to the CFA Institute:
Conceptually, residual income is net income less a charge (deduction) for the opportunity cost of common shareholders in generating net income. It is the residual or remaining income after taking into account the costs of a company’s entire capital.
Regarding my ServiceNow stock valuation model, I make the following assumptions:
- To forecast EPS, I rely on analyst consensus forecasts available on the Bloomberg terminal through 2026. In my opinion, any estimate beyond 2025 is too speculative to be included in a valuation framework. But over 2-3 years, the analyst consensus is generally quite precise.
- To estimate the capital charge, I rely on NOW’s cost of equity at 9%, which is roughly consistent with the CAPM framework.
- For the final growth rate after 2025, I proudly apply a rate of 4.25%, which is about 150 to 175 basis points above the estimated nominal growth of global GDP. The growth premium is expected to reflect the high potential of technology companies in general, as well as NOW’s penetration white space.
Given these assumptions, I calculate a base price target for IBM stock of approximately $320/share, suggesting a downside of over 50% based on fundamentals and consensus estimates!
I recognize that investors may have different assumptions regarding these rates. Therefore, I have included a sensitivity table to test different scenarios and hypotheses. See below.
I’m bearish on ServiceNow stock, primarily based on valuation. However, there may be some “upside risks” that could make ServiceNow’s valuation less notable. Specifically, I highlight that a strengthening global GDP outlook could spur increased IT spending, particularly in segments such as consulting and software, putting upward pressure on consensus EPS estimates and strengthening NOW’s financial outlook. Additionally, market sentiment towards high-growth technology stocks, supported by expected rate cuts in 2024, could positively influence the company’s stock performance and investor perception.
Takeaways for investors
ServiceNow has seen strong growth in the past and the company is poised for new growth potential as the NOW platform could play a crucial role in digital transformation. On this subject, I highlight that ServiceNow has vast market space and growth potential with an estimated total addressable market of $220 billion, providing a backdrop for a 21% CAGR through 2028 Additionally, I believe ServiceNow is advantageously positioned to experience the near-term tailwinds of the generative AI evolutionary cycle. That said, it is impossible for me to justify an investment 15x EV/Sales. Additionally, many valuation concerns are compounded by the company’s sales-driven business model, with SG&A costs accounting for nearly 60% of the company’s gross profit. In conclusion, I calculate the intrinsic value of NOW to be $320/share.